Obama’s deficit reduction plan released last week includes a proposal to lower the cap on the maximum allowable executive compensation reimbursable to federal contractors. Sounds ominous, but what does it mean? Under federal law, the Office of Management and Budget is charged with the responsibility to set a cap on the amount of executive compensation that can be included by government contractors in their overhead pools and allocated to their cost-reimbursement contracts. This issue is also addressed in the cost principle set forth in FAR Part 31 (31.2056(p)). The cap (also known as the “benchmark compensation amount”) is supposed to reflect the median compensation amount for the five most highly compensated employees of corporations with revenues in excess of $50 million. The median compensation of these executives, in turn, is taken from information provided by the SEC (which generally requires publicly traded companies to disclose compensation paid executives). “Compensation” in this context means the total amount of wages, salary, bonuses and deferred compensation provided executives.
For FY 2010, OMB set the cap at $693,951, up slightly (1.4%) from $684,181 the prior year. The cap remains in place until revised by OMB. What has grabbed headlines recently is that Obama’s deficit reduction plan proposes to reduce the cap to $200,000. This amount reflects the cap on salaries given senior federal executives such as a cabinet-level secretary and is designed to put contractor executive salaries on par with federal executive salaries.
The proposal certainly seems like a serious blow to contractors. The difference between a cap of almost $700,000 and a cap of $200,000 is substantial. More importantly, Obama’s proposal completely ignores the formula for the cap authorized by statute. Under the applicable statute, the cap is supposed to be set following a comparison of contractor salaries to salaries of other commercial companies. A comparison of contractor salaries to federal salaries is not an apples to apples comparison. Stan Soloway (of PSC fame) makes the same point in an article published in the Washington Business Journal last week. (A copy of the article can be foundhere) Others quoted in the article warned that Obama’s proposal would result in the exodus of many government contractor senior executives to commercial companies. (Interestingly, no one suggested that the reduction in the cap would lead to an exodus of government contractor executives to the Government. One wonders if Obama was seeing the cap reduction as another “insourcing” mechanism or a way to stop the “brain drain” in the Government).
The proposal, however, may not be as shocking as it first appears. First, the proposal only addresses the amount of compensation contractors can seek to have reimbursed for their five most highly paid executives. It does not propose to cap compensation provided other executives or employees. Second, the cap only affects the amount the Government will reimburse contractors through their cost reimbursement contracts; it does not cap the amount contractors can actually pay their executives. Second, as the Washington Business Journal article also points out, most senior executives are not compensated solely through salary. Instead, their compensation often is a combination of salary and equity in the company. To the extent that the amount of salary that can be recouped through cost contracts is reduced, companies likely will make up the difference in increased equity compensation. Third, in order for the proposal to become law, the current statute will have to be amended or rescinded by Congress. However, consensus is not the hallmark of this Congress. Thus, Obama’s proposal may be nothing more than posturing in a campaign year.
What is troubling is that Obama’s proposal is a familiar refrain: Government overspending results from the high prices the Government pays its contractors. The $500 hammer remains embedded in everyone’s minds and, as a result, contractors are the predictable, easy and traditional scapegoat in a budget crisis. If the Government really wants to reduce the amount of government contractor executive compensation it reimburses, it just needs to move from cost reimbursement contracting to fixed price contracting. This move, in fact, has recently been suggested by DoD. The problem with fixed price contracts from the Government’s perspective is that it places the onus on the Government to clearly state and predict its requirements. It requires hard work up front; cost reimbursement contracting, by contrast, is the easy way out. Criticizing federal employees, however, is not likely to win an election. Taking on contractors, on the other hand, is a bit like taking on Wall Street. A villain everyone can agree on.